International Financial Organization: the Behavior of Governments and Financial Institutions - Essay Example

Page Principles of Finance Contents Page Page i Contents Page ii Q1: Financing in Three Continents Q4: Lessons Learned 5 Q5: CFOs and the Corporate Mission 5 Table 1: Total Equity and Debt Issues (2001-2006) 7 Figure 1: Selected Indictors on Capital Markets (2005) 8 Figure 2: Sectoral Balance Sheets for U.S., Japan, & Europe 9 Figure 3: Equity Markets Indices (1990-2006) 10 Figure 4: Volatility History in Equity Markets 11 Figure 5: Historical Volatility of Bond Yields and Returns 12 Works Cited 13 Q1: Financing in Three Continents Table 1 shows the amounts raised by issues of stocks and bonds from 2001 to 2006 in the U.S., the U.K., and in Japan. The figures were derived from the latest (2007) statistics of the Bank for International Settlements (BIS) based in Basel, Switzerland and the 2006 Global Financial Stability Report of the Washington, DC-based International Monetary Fund (IMF). The BIS is the world's oldest international financial organization that serves as a bank for central banks. The IMF is an organization that promotes international monetary cooperation, exchange stability, and orderly exchange arrangements to foster economic growth. Together, they help promote stability and balance in the behavior of governments and financial institutions through surveillance, financial, and technical assistance. Based on the summary in Table 1, $282.978 trillion was raised in Japan, the U.K., and the U.S. from 2001 to 2006 from IPOs, debt offerings, and mergers and acquisition activities throughout the world. Of this, the U.S. accounted for 26%, while the U.K. had 9.7% and Japan only 2.3%. The declines from 2001 to 2003 resulted from the dotcom bubble explosion and corporate scandals in the late 1990s until 2001, affecting investor confidence and the ability of firms to raise funds. However, the increasing amounts since then signify a steady recovery that continues to hold. The U.K. issues more equity than either the U.S. or Japan, the U.S. issues more debt securities than the other two countries and that in these three countries debt issues are greater than equity issues by an overwhelming factor of almost 280-to-1. What could explain these findings Figures 1 and 2 (IMF, 2006; BIS, 2006) show that most debt issues are from corporations, and that Japanese (101.7% debt-to-equity) and European (69.6% debt-to-equity) corporations have more debt than U.S. companies (43.1% debt-to-equity). This explains why Japan and the U.K. issued lower amounts of debt compared to the U.S. during the period. Second, debt yields are lower in Japan compared to the U.S. and the U.K., and while equity yields are higher in the U.S. than in the U.K. and Japan, debt returns (5 to 11%) are higher than equity returns (-33% to almost 0%) in all three countries, and interest rates are declining. This means debt is more attractive to issuers and investors than equities. For investors, debt returns are higher, so they would rather lend their funds. For companies, debt is also cheaper since the trend for interest rates is flat to declining. Therefore, investors and corporations both prefer debt over equity. Q2: Vodafone plc Case Analysis Vodafone plc (2006: 2-3) is a London-based telecommunications company with total turnover of 29.4 billion, assets of 127 billion, and over 170 million customers worldwide, making it the biggest telecoms firm in the world. With debt of 20.1 billion and stockholders' equity of 86.9 billion, it has a debt-to-equity ratio of 23%. Net debt is 17.3 billion after taking out cash and cash equivalents. Vodafone raises funds in various currencies by issuing debt securities because it has a good financial network in London, the world's financial center. The company's policy (Vodafone, 2006: 41) is to maintain the currency of debt and interest charges in proportion with expected future principal multi-currency cashflows, which explains why 113% of its net debt is in currencies other than sterling: 73% of debt is in Euro, 21% in Yen, 14% in US Dollars, and 5% in other currencies whilst 13% of net debt is in purchased forward options in anticipation of sterling denominated shareholder returns via share purchases, dividends, and share distribution. Since sterling is stronger than other currencies (the Euro, US Dollar, and Yen), it borrows funds for operations and to pay dividends in sterling. If the sterling weakens against certain currencies in which Vodafone has foreign debt, this would result in an increase in net debt from currency translation differences. However, if sterling strengthens against all exchange rates, which has been happening in the past few years, operating profit would increase and this would be good for shareholders. Since the company generates revenues in several markets, dominated by the U.S. and Europe, it has so far been able to fund these foreign debt exposures using the host currency. Among the many reasons why borrowing looks better for Vodafone are tax shields and dividend policy. Dividend payments are non-taxable in the U.K., so borrowing to pay dividends is cheaper. Besides, debt helps management focus on improving performance because it is an obligation (Wruck 1995; Jensen and Murphy 2004), making it easier to use long- and short-term debt to meet anticipated funding requirements, to increase dividend payout ratios to 60% and improve shareholder returns, and to support its business strategy (Vodafone 2006: 40-41). Since its Total Shareholder Return performance is below its FTSE 100 industry and market peers, the management is pressured to pay dividends to send the message that it can make up for poorer performance by paying out a share of profits (p. 64). Foreign debt markets allow Vodafone to issue debt, giving them the cash needed to fund operations, and at the same time free some cash from operations to pay dividends to shareholders. Access to London, the world's financial capital, is certainly an advantage because the company can raise funds in foreign currencies from the same place where it does business, compared to its bigger competitors from Germany, Japan, or the U.S. Q3: Funding a Start-Up Self-financing would be out of the question as it would take hundreds of millions of U.S. dollars to assemble and sell these products in the global market. The presence of giant competitors that manufacture mobile phones makes it easier, though perhaps not as profitable, to tie-up with an established manufacturer. The start-up can sell the design to industry leader Nokia which can then manufacture the units and pay a royalty. However, assuming the start-up founder is daring enough to face the giants and decides to raise funds, the best way is through venture capital financing. Without a track record of financial performance, it is impossible to list in the stock market or to issue debt. The stock and debt markets are highly regulated and require mind-numbing paperwork showing the company as being profitable which, for a start-up, is difficult to prove. So a venture capital fund would be the best option. Venture capitalists provide funds to high-risk start-ups. They demand high returns for their investment, but the experience of several corporations now listed in stock markets, such as Google, Microsoft, and eBay, show that venture funds can generate good returns and rewards. Venture capitalists ask for high carrying costs through fees or 'interest' payments, usually 20-30% yearly if the start-up is generating revenues and show promising profits. The other advantage is that venture capitalists provide valuable management experience that helps the start-up find its way around the market. In two to three years, once the start-up begins generating a good record of profits, these venture capitalists can adopt an exit strategy of listing in the stock market, selling a portion of the company, usually less than 50% so that the original owners and the start-up's founder(s) retain the huge upside potential benefits from the generation of future value from profits (Gupta 2000: 326-328). If, however, the company continues to have problems or ekes out profits that are below expectations, these same capitalists can just issue debt using their 'character' as collateral, nurturing the start-up until it is ready to be listed in the market well enough to attract a diversified group of public investors (Gupta 2000: 134-135). Q4: Lessons Learned This paper was a great learning experience as substantial research had to be done about global financial markets, data analysis, and comparisons of information sources such as conversations with experienced business and finance professionals. Writing the paper was an exercise in time management, ordered thinking, and learning to work with people who provided and analyzed data and turned these into useful information, helping the writer realize that while financial issues look easy, things in the real world can be complicated. This shows the challenges that finance executives face daily. Raising funds is the easy part, but making funds earn above the average demands the right strategic decisions to increase investment value. Deciding which of several options to choose to raise funds, and monitoring events and forecasting their effects on rates, indices, debt- and stock prices, growth rates, inflation rates, the capacity of customers to buy goods and services, etc. are challenging tasks. There is so much money in the world looking for good investments in the form of good business ideas that a creative mind could produce. No guts, no glory! Q5: CFOs and the Corporate Mission The company's excess funds can be invested in companies that engage in socially responsible activities or those that do not take advantage of workers in developing countries to make profits by giving sub-standard wages or destroying the environment. This ensures funds are put to good use to benefit the company's stakeholders. The CFO can also invest a portion of the profits into projects where employees can participate, such as building houses for the poor or increasing wages of workers to generate goodwill for workers and customers in their home and host countries. Lastly, employees can be encouraged to speak out when they notice anyone, especially among the managers, engaging in unethical financial and accounting practices. Hopefully, this would avoid another Enron or Tyco in the future. Tables and Figures Table 1: Total Equity and Debt Issues (2001-2006) All figures are in billions of U.S. dollars Equity Issues (1) 2001 2002 2003 2004 2005 2006 Total % share All countries 150.588 103.318 121.956 219.386 307.798 377.877 1,280.923 Japan 7.004 2.481 6.361 8.033 9.890 11.778 45.547 3.6% United Kingdom 30.815 14.771 8.110 21.403 34.562 41.901 151.562 11.8% United States 24.821 1.275 2.694 1.717 5.939 14.699 51.145 4.0% Debt Issues (2) 2001 2002 2003 2004 2005 2006 Total % share All countries 28,692.001 34,704.464 42,550.762 51,159.332 56,994.510 67,596.483 281,697.552 Japan 1,056.159 1,005.483 1,011.897 1,139.858 1,137.611 1,218.427 6,569.435 2.3% United Kingdom 2,313.710 2,862.952 3,821.982 4,971.782 5,876.187 7,389.505 27,236.118 9.7% United States 8,426.556 10,361.766 11,561.171 12,931.396 13,762.818 16,132.227 73,175.934 26.0% Debt + Equity 2001 2002 2003 2004 2005 2006 Total % share All countries 28,842.589 34,807.782 42,672.718 51,378.718 57,302.308 67,974.360 282,978.475 Japan 1,063.163 1,007.964 1,018.258 1,147.891 1,147.501 1,230.205 6,614.982 2.3% United Kingdom 2,344.525 2,877.723 3,830.092 4,993.185 5,910.749 7,431.406 27,387.680 9.7% United States 8,451.377 10,363.041 11,563.865 12,933.113 13,768.757 16,146.926 73,227.079 25.9% Total Derivatives (3) 2001 2002 2003 2004 2005 2006 Gross Outstanding 111,177.84 141,665.15 197,166.93 257,894.30 297,669.57 415,182.53 Notes: (1) Includes IPOs and Mergers and Acquisitions. (2) Does not include derivatives which accounted for $415 trillion outstanding as of end-2006. (3) Includes interest rate, currency, equity-linked contracts, forwards and swaps, options, commodity contracts, gold, credit default, and single- and multi-name instruments. [Sources: IMF 2006; BIS 2006] Figure 1: Selected Indictors on Capital Markets (2005) [Source: IMF 2006] Figure 2: Sectoral Balance Sheets for U.S., Japan, & Europe [Source: IMF 2006] Figure 3: Equity Markets Indices (1990-2006) [Source: IMF 2006] Figure 4: Volatility History in Equity Markets [Source: IMF 2006] Figure 5: Historical Volatility of Bond Yields and Returns [Source: IMF 2006] Works Cited Bank for International Settlements. Securities Statistics and Syndicated Loans. March 2007. 28 May 2007. Gupta, Udayan (Ed.). Done Deals: Venture Capitalists Tell Their Stories. Boston, MA: Harvard Business School Press, 2000. International Monetary Fund. Global Financial Stability Report: Market Developments and Issues. Washington, DC: IMF, September 2006. Jensen, Michael C. and Kevin J. Murphy. "Remuneration: Where we've been, How we got to here, What are the problems, and How to fix them". Finance Working Paper No. 44/2004: European Corporate Governance Institute (July 2004). Vodafone. Expanding the Power of Mobile Communication: Annual Report for the Year Ended 31 March 2006. Newbury: Vodafone Group plc, 2006. Wruck, Karen H. "Financial Policy as a Catalyst for Organizational Change: Sealed Air's Leveraged Special Dividend". Journal of Applied Corporate Finance 7 (Winter 1995): 20-37. Read More